Mack of Morgan Stanley (NYSE: MS) and Fuld of Lehman (NYSE: LEH) have both expressed the opinion that the worst of the Wall St. earnings crisis may now be in the past. The head of UBS (NYSE: UBS) also thinks his bank’s worst news is out.

All of that is true until it isn’t. Word is spreading that Merrill Lynch (NYSE: MER) may take write-offs of $6 billion to $8 billion for the last quarter. According to The Wall Street Journal, Merrill made bigger and bigger bets on the CDO market as 2007 went on. The net result, writes the paper, "would bring its total (write-downs} since October to more than $30 billion." That is a lot of money, even for Merrill Lynch.

The hardest news is not all out. If mortgages continue to default, and that number was up 57% in the last month, paper based on this lending could have further problems. The equity line of credit ARM market now totals $4 trillion. Other consumer loans will fail and a trying economy should bring down the value of LBO debt.

Looking forward in hope may give some short-term comfort to those who do not know any better. Insiders know something different. Credit default swaps rose 37% from the first half of last year to the second and hit $62.2 trillion. That is a lot of capital bet on negative news.

The low end of EPS estimates for banks and brokerages still reflects a deep pessimism about the system. If financial companies come in at or below those bleak numbers, share prices across the industry will fall and there will be more demand for new capital.

That capital will ask for frighteningly favorable terms.

Douglas A. McIntyre

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